The Bank of Canada took a good look at the Canadian economy, saw it was sinking into the mire, glanced at the collapsed prices of commodities, particularly oil, saw how they were wreaking havoc in Canada, and then looked at the global economy, particularly at China and the US, and it freaked out.

It cut its overnight rate 25 basis points to 0.5%, the second rate cut this year, and attached a gloomy view about the Canadian economy with as it said a “significant downgrade” from its last estimate issued only in April. Things are heading south fast.

In his opening statement, Governor Stephen Poloz blamed oil, China, and dropping exports, particularly to the US which is “still a puzzle that merits further study,” he said, as the swooning Canadian dollar should have pushed up exports. The three culprits:

First, Canadian oil producers have lowered their long-term outlook for global oil prices, and have cut their plans for investment spending significantly more than previously announced.

Second, China’s economy is undergoing a structural transition to slower, domestic-driven growth, which is reducing Canadian exports of a range of other commodities.

Third, Canada’s non-resource exports have also faltered in recent months. While this is partly due to the first-quarter setback in the U.S. economy, it’s still a puzzle that merits further study.

This splits the economy in two, with the “resource economy” falling off a cliff, and with the “non-resource economy” motoring forward. Alas, they’re “not independent – the cancellation of an investment in the oil patch will often lead to a hit in the manufacturing sector, for example.”

Ah yes, and the ballyhooed positive effects of lower oil prices? They “have been slow to emerge.”

The non-resource economy was supposed to pull out the rest, something the BOC expected “to begin in the second quarter. But it did not….” Why not? Poloz blamed the three culprits above. And that propitious moment is now rescheduled for the third quarter. Or maybe later.

But the rate cut comes at the price of “financial stability risks” which “remain elevated,” Poloz said. “Of particular note are the vulnerabilities associated with household debt and rising housing prices.”

Household indebtedness, driven by ballooning mortgages, has soared over the years. The household-debt-to-disposable-income ratio now hovers at 163.3%. And home prices, funded by this boom in debt, have also soared. They now exceed the peak of the prior housing bubble by 27% on average across major metro areas, and in Toronto by 45%.

It’s a majestic housing bubble. Even the IMF is fretting about it. When housing bubbles implode they do enormous damage to the real economy and to the financial system.

But rather than trying to tamp down on it, the Bank of Canada is going to feed it with even cheaper money, while openly fretting about it… Governor Poloz warned that the rate cut “could exacerbate these vulnerabilities.”

However, these “financial vulnerabilities would usually translate into full-blown risks – with attendant consequences for the economy – only if there was a trigger,” he said. But these triggers are already visible, such as:

A widespread and sharp decline in economic activity and employment.

The terms-of-trade shock we are experiencing, which has already translated into an increase in excess capacity and downward pressure on inflation…, if left unaddressed.

So “the Canadian economy is undergoing a significant and complex adjustment, even while it is still trying to overcome persistent global headwinds.”

While it was at it, the BOC slashed its Q2 “growth” estimate from a positive +1.8% in April to a negative -0.5%. That’s a huge cut from just three months ago! And it comes on top of the contraction (-0.6%) in the first quarter. Even the BOC is now admitting that Canada is in a technical recession – two quarters in a row of contraction.

It also slashed Q3 growth from 2.8% in April to 1.5%, still a positive number that, given the “global headwinds,” may be tough to achieve. But it left Q4 unchanged at 2.5% because “solid household spending” would by then “be supplemented by a continued recovery in non-energy exports and investment.”

That’s the hope. It brings the growth forecast for 2015 to a measly but still optimistic 1.1%. Three months from now, the BOC will slash it further.

It also cut its growth forecast for 2016 to 2.3%. A lot of good things would have to happen around the globe, including surging oil prices, for this to happen. And the housing bubble would have to continue to bloom, or else, it would turn into one of the “triggers” for financial instability that Poloz is worrying about.

This was a big dose of gloom for just one statement. In sympathy, the already beaten-down Canadian dollar plunged 1.5% against the US dollar, hitting the lowest level since February 2009.

Written between every line of the statement was the housing bubble, the risk it posed to the economy and to financial stability, and the tradeoffs the BOC had to consider.

A collapse of the housing bubble would be one of the “triggers” to financial stability risks. Hence the need to keep it inflated. Hence the rate cut. But the cut will in turn “exacerbate these vulnerabilities,” as Poloz admitted. That’s the Catch-22 a loosey-goosey monetary policy finds itself in sooner or later: no matter which direction policy goes – rate cuts, no change, or rate hikes – it simply exacerbates one or the other of a slew of already enormous risks, each of which could trigger a major debacle.

Crazy! Don’t know what the heck they think they are doing, and am not even sure they know.

What I know is that it was a stupid move, something not normally expected from the BOC. At these low levels a 1/4 point drop in rates will not do anything positive for the economy. Whether rates are .75% or .5% does not make any difference.

The big impact is on the dollar, and we are already starting to see big inflation coming our way, especially at the grocery store, but also on all imported goods. The BOC risks starting an inflationary explosion with this stupidity, after which of course they will have to raise rates.

They should have done NOTHING and waited for the impact of the lower dollar to feed through (the lag is longer than they think).

That said our company is loving it. We export to the US and 90% of sales to the US and worldwide are in US$, and we have not adjusted US$ pricing, so all of this collapse in the C$ feeds right to the bottom line (minimal imported components in our goods). BUT … we won’t be hiring anyone new anytime soon. Demand is flat … but profits are great … but it is demand that drives hiring, and it ain’t there, so we just build up the bank balance ad wait.

cocoabean

Jul 16, 2015 at 12:59 am

Their real objective is to achieve just what central banks are supposed to do: debase the currency. Counterfeit. All with the aim of giving investors and spenders the wrong signals, to induce them to take on unjustifiable risk…misallocation of capital.

You know, Keynesianism…another crackpot 1930s theory cooked up and promoted in the wake of The Great Depression. Something like Social Credit, Technocracy or the Oxford Group movement…

cocoabean

Jul 15, 2015 at 9:01 pm

If they’d stop looking solely at “big companies” and macro-borrowing statistics, they might notice that Main Street has long been dead on its back and never got out of the LAST recession…

NotSoSure

Jul 15, 2015 at 9:31 pm

What’s the fair value of the Loonie at this time? 1.5?

Paulo

Jul 15, 2015 at 9:40 pm

A fairer question is what is the worth of the US dollar right now, and why does it have that relative value? Come on, the US economy is toilet water. Supposedly Canada is worse off, but in the scheme of things Canada has space, water, arable land, and a low population per area.

What would you call the better place to be as this unwinds?

Paulo

Jul 15, 2015 at 9:42 pm

I forgot to add….balanced budget.

night-train

Jul 16, 2015 at 3:13 am

I believe you have correctly stated the critical difference between Canada and the US. But, what we have in common is more important and that is, this time around it looks like we are going down together. Hoisted on our own petards. Perhaps there will be some comfort in our shared experiences.

Ray

Jul 16, 2015 at 5:23 am

Bumbling incompetence is the story they sell us. I think there is more to this. These people understand the consequences of these actions and I think that is what they are aiming for. Why, I am not sure of.

Spencer

Jul 16, 2015 at 5:58 am

All the central bankers take their marching orders from the BIS. Pure and simple, follow the script laid out for you. This guy worried, right. Same b.s. as Yellen.

Debtserf

Jul 16, 2015 at 7:27 am

Not to worry – Canada has just been unveiled as the country with the ‘best reputation’ in a survey on global perceptions. For what it’s worth.

JonLaughing

Jul 16, 2015 at 10:10 am

Poloz comes from the Grrenspan, Bernanke, Yellen, Carney school of alchenomics. So what else to expect than the imagination that a .25% reduction will keep things on track. And you just gotta love the predictions for 2016 and 2017. Life is rosey and couldn’t get better. All it takes is the guaranteed growth in the USA and a stable China and a prosperous third world and it will all trickle down to Canada – thanks to the good policies at the BoC. All praise to Poloz.

LG

Jul 16, 2015 at 11:05 am

Credit = debt = slavery

Credit is the new gold!

economicminor

Jul 16, 2015 at 11:23 am

LG, debt slavery works well for those power hungry greedy bastards. They get the hard work of a slave and they have no responsibility to take care of them. Interesting world we live in hey!

LG

Jul 16, 2015 at 12:42 pm

Bingo! The reason we no longer need gold.
Debt pays better then gold, it can be sold and bought with no storage ever needed!
The future is for the banksters! Until a revolution.

Julian the Apostate

Jul 16, 2015 at 2:01 pm

Being able to predict where relative safety will be after the crash is as hard to predict as when the crash will happen. I think cities on the whole will be less safe than rural areas. Beyond that I haven’t a clue.